Sunday, June 11, 2006

The Peak Oil Crisis: One Year in Review

Falls Church News-Press

By Tom Whipple
June 8, 2006

As the world oil situation is rather quiet at the minute, it's a good time for a review. The price of oil continues to bounce around $70 a barrel and shows no sign of moving very far in either direction until the next big development occurs. The Iranians are busy trying to decide how much they really want an atomic bomb (or at least the ability to make people think they have one). The wrong decision by either side could impact world oil supplies and prices for years to come. Finally, the Nigerian militants have managed to abduct and probably ransom a group of foreign oil workers from an exploration platform 40 miles offshore.

The most obvious-to-everybody development in the past year is that the average US price for gasoline has managed to climb by 77 cents a gallon. So far the economic damage has been well below what many observers had thought $3 a gallon would do to the economy. However, there are signs of trouble ahead. Sales of large SUVs are on their way down, inflationary numbers are starting to appear, and Wall Street is having bad days. While for many people $3 a gallon is something one gets used to, many others are rapidly on the way to maxing out their credit cards or hocking the family heirlooms to get to work.

The other hard-to-miss events of the past year were the big Gulf of Mexico hurricanes. Whether you believe in global warming or not, the waters in the Gulf and mid-Atlantic have gotten a lot warmer in recent years resulting in two consecutive seasons in which Gulf oil production was badly torn up. Last year's hurricane season resulted in the permanent loss of some 200,000 barrels a day of oil production. While no one knows as yet if this year's hurricanes will do damage comparable to the last two years, all the climatological prerequisites for another bang-up hurricane season are in place. Gulf oil and natural gas production has grown into a mighty big target.

During the past year, a pair of internal company documents were leaked in Mexico and Kuwait . The Mexican document suggests that production from the giant Cantarell oil field from which the US imports 1.6 million barrels a day is about to collapse catastrophically. In the case of Kuwait , the leaked study claims that the country's oil reserves may only be 25 to 50 percent of the official number. In the meantime, Kuwait has announced that production from their giant Burgan oil field has started to decline.

The status of Saudi oil production, which many believe to be the key to any further growth in world oil production, remains a well-guarded state secret. Here too, however, there are tantalizing hints of trouble ahead. Riyadh continues optimistic claims about future production capabilities and has embarked on major new onshore and offshore drilling projects, paying top dollar to lease the required equipment. For most of the last year, Saudi oil production has been steady at 9.5 million barrels a day at a time when world oil prices and presumably demand has increased. Recently a firm of "tanker trackers" announced that it looked to them as if Saudi production had dropped to around 9.1 million barrels a day in April and May. The number for April has been confirmed by the Saudis who claims they simply can't find buyers for their oil.

It may be perfectly true that the Saudis can't find a market for some of their oil. A lot of it is difficult to refine and a growing share of the world's oil consumers simply can't afford the going rate these days, even as the richer countries continue to grow nicely. A number of outside analysts are saying that it is just about time for Saudi production to go into decline, perhaps catastrophically. In a year or so, we should know who is right.

Also, keep in mind that stopping Saudi oil production is still Al Qaida's top objective. They failed in an attempt to blow up a key chokepoint a few months back, but they are still out there and not getting any friendlier.

We all know where the Iraqi situation is going and that it is only a matter of time until oil exports, which are doing nicely at the minute, are drastically reduced or come to a complete stop. The Iranian situation is in limbo at the minute. Decisions in the next few weeks should settle whether exports and further oilfield development continue or the situation deteriorates into any of several possibilities that will increase to price of oil or perhaps markedly reduce the amount of oil coming out of the Middle East .

A major phenomenon of the past 12 months has been the scramble for secure oil supplies that has been taking place around the world. The Chinese have been particularly active in seeking out new deals and signing contracts for oil. Close behind China in the search for bilateral agreements have been the Japanese and the Koreans who are faced with the problem of growing industrialized economies and no indigenous oil. There appears to be a trend getting underway from market-based oil sales, where “he who pays the most gets the oil,” to a situation where exporters are selling to customers under direct bilateral agreements.

Thanks in part to the hurricanes, US oil production thus far in 2006 is down by 400,000 barrels a day (7.3%) as compared to 2005. Our net imports of crude and finished products are up by a comparable amount. This means that roughly two thirds of US oil consumption is now being imported and therein lie the seeds of a problem more serious for the US than the peaking of world oil production: peak US oil imports.

Let's face it, during the last year, the popularity of the US around the world has not been doing too well. Many see a way to do us real harm through cutting or slowing our access to oil. Nationalism is on the march in many places. A few countries led by Venezuela are saying that as soon as they can figure out how to stop exporting oil to the US , they will.

It is gospel that when an exporting country goes into depletion they will keep supplying the domestic market first so that their exports will drop much faster than their total production. Moreover, we are starting to hear talk about cutting back on exports just to save it for another day. The message of rapidly rising prices is that an exporter can earn growing revenues and keep more of his oil safely in the ground too, simply by slowing exports. The only obstacles to deliberately slowing exports are long term contracts, other trade relationships, security guarantees, and the fear that they could end up like Baghdad .

So what does the past year tell us? First of all, world oil production has moved up very little. While new wells and new oil fields continue to be drilled, this increased production has been largely offset by hurricane damage, insurgencies, and general oil depletion. The year of peak oil production will be determined by the balance of how fast the drillers can open increasingly more expensive and difficult to drill wells vs. mother nature, insurgents bent on closing down production, and increasing rates of world oil field depletion.

The US and other industrialized countries, most of which are, or soon will be, major importers, are facing the double whammy of rapidly reducing supplies of oil available for import. In the meantime, and for the moment, the worldwide demand for oil, even in the US , continues to increase.


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